ABSTRACT:
This paper investigates the joint dynamics of multiple nominal exchange rates under a multicountry framework. Using a no-arbitrage macro-finance approach, information of macroeconomic fundamentals is employed to model exchange rate dynamics. Meanwhile, macroeconomic fundamentals are assumed to be determined by global (common) factors as well as by country-idiosyncratic factors. To do the empirical study, I mainly focus on an open economy including four countries, i.e. Germany, the UK, Japan and the US (the US dollar being the numeraire currency). The empirical results show that this model is able to explain 57%, 66% and 33% variations of the observed movements of the USD/DEM(EUR), the USD/GBP and the USD/JPY, respectively. This model implies foreign risk premiums satisfy the Fama condition (1984) and they are counter cyclical with respect to the US economy. Moreover, global and country-idiosyncratic macroeconomic factors do exist and play very different roles in driving
exchange rate dynamics and foreign risk premiums.